History haunts Hynix

High yield bond enables Korean chip manufacturer to graduate from creditor programme - at a price.

Hynix Semiconductor priced a two-tranche high yield bond in New York on Friday raising $500 million via joint bookrunners Deutsche Bank, Citigroup, Merrill Lynch and UBS.

Completion of the B+/B1 rated deal means Hynix will be able to release itself from a Creditors Restructuring Promotion Act (CRPA) 18 months ahead of schedule. Back in 2001, Hynix's creditors took control of the company via a debt-for-equity swap after it succumbed to a $10 billion debt burden and severe industry downturn.

In order to begin the process of re-gaining management control, Hynix needed to re-pay them. It initially set out with plans to raise $2 billion, of which $750 million would be raised via a term loan, $500 million from a revolving credit facility and $750 million from the high yield bond market.

Of the $1.5 billion it intended to raise up-front, $1.384 billion would be used to re-pay creditors and $166 million to boost its cash reserves. To this effect, a $750 million loan was signed at the beginning of June.

But the downsizing of the high yield bond from $750 million to $500 million, means the group has fallen slightly short of its $1.384 billion target. However, observers say it has the leeway to either draw down part of the credit facility (also put in place at the beginning of June), or re-pay part of the CRPA at a slightly later date.

Either way, Hynix has had to pay a high price to try and secure its freedom from the Korean banking sector. Partly this can be attributed to market conditions and partly to its own credit history.

After being shut for three months, the Asian high yield market has recently begun to shown signs of life, but only to names investors know and trust such as PT Indosat. Hynix is not one of them.

More importantly perhaps, investors believed the company had ceded them all the pricing power because it had no choice but access the market. Unsurprisingly, this meant pricing on both tranches of the bond was significantly higher than the company feared it would have to be.

The most affected tranche was a $500 million 10 non-call five, fixed rate tranche. This was restructured to a $300 million seven non-call four tranche.

Pricing came at 97% on a coupon of 9.875% to yield 10.491% or 670bp over Treasuries.

The FRN tranche was not altered and this comprised a $200 million seven non-call two issue. This was priced at par with a coupon of 650bp over Libor. The call option has a sliding scale of 103%, 102%, 101% and par thereafter.

Fees for the deal total 1.875%, or $9.375 million. However the company's financial advisor Deutsche Bank has superior economics because it was the sole underwriter in the US where a large percentage of the bonds were placed.

The other three banks were joint bookrunners in Asia and Europe.

Observers say the fixed rate tranche attracted demand of $1.6 billion and participation by 154 accounts. By geography, 29% went to Asia, 24% to Europe and 47% to the US. By investor type, 57% went to funds, 6% to banks and 37% to retail/insurance/other.

The FRN tranche attracted demand of $600 million and participation by 74 accounts. By geography, 48% went to Asia, 4% to Europe and 46% to the US. By investor type, funds took 40%, banks 51% and retail plus insurance the remaining 9%.

Observers say the order book was fairly price insensitive at the final pricing level and that it was Hynix's decision to scale the deal back because it was not happy with such high pricing

The bond's harshest critics wonder why the company was trying to tap the high yield market in the first place. Some say Hynix management wanted to launch a domestic bond deal, but were pushed into the international high yield market by KEB. The latter is chief creditor to Hynix and one of its officials acts as Hynix chairman.

KEB's rationale is said to be two-fold. Firstly it wants to sell out of Hynix as soon as it can because its own majority owner, Lone Star, wants to sell out of KEB at a premium as soon as it can. Secondly, it wanted to reward Deutsche Bank for all the advisory work it has done.

The company's supporters refute this and say an international bond made sense because it diversifies Hynix's funding sources and lengthens its maturity profile. The former is particularly important.

Hynix will need to retain access to the domestic bond market in order to fund its future capex. It will not have much leeway to raise equity finance until the creditors have sold down their stock through the secondary market.

So too, the call schedule gives Hynix room to redeem the expensive high yield debt if it can generate sufficient cash flow over the next few years. At the beginning of roadshows, the secondary market trading levels of the company's main comparable also suggested it would not have to pay too much of a premium to the kind of levels available in the domestic bond market.

The main comparable is Korean chip manufacturer Magnachip, which completed a $750 million three-tranche high yield bond last December. Magnachip and Hynix share the same issuer rating of B+/Ba3.

Hynix's current bond has a lower rating of B+/B1 because of its structural subordination to the loan. So too, one of Magnachip's three tranches was unsecured.

This comprised a $250 million 10-year tranche with a lower B2/B- rating and an issue price of par to yield 8% or 382bp over Treasuries. Since pricing, bankers say the bond has been highly volatile, veering from the low 9% range to as high as 12%.

At the time Hynix went on the road, it was said to have traded back to the low 9% mark again. Theoretically Hynix should have been able to price through this level. It is a higher rated credit with a much stronger balance sheet and the final bond had a shorter maturity.

The only other comparables come from the CB asset swap market. Because of the highly volatile nature of the DRAM industry, most companies in the sector fund themselves through straight equity, or through the convertible bond market. Investors feel more comfortable with the shorter maturities available in the CB market because they provide a better match to the short-term visibility of industry fundamentals.

Micron, ProMOS Technologies and Powerchip all have CB's outstanding and bankers say they are being quoted at 300bp to 500bp over Libor for maturities ranging from two to four years.

Hynix was not in a position to access the equity or CB markets, however. None of its creditors would have agreed to dilute themselves before divesting their combined 81% stake. This process should now begin, with the creditors set to reap the rewards of a 170% plus stock price appreciation over the past year-and-a-half.

Once Hynix is free of CRPA, the creditors are free to divest up to 30% immediately and the remaining 51% after 2007.

The main reason why the company got into trouble in the first place is because its former owners - the ever expansive Hyundai chaebol - purchased LG Semicon in 1999 and funded it with short-term debt that could not withstand a severe downturn in the industry.

By 2001 the company had disaffiliated itself from the Hyundai group, appointed new independent managers and secured a Won5.6 trillion restructuring agreement from creditor banks (then worth $4.3 billion). This restructuring agreement was contingent on the completion of a capital markets transaction, which was completed later the same year raising $1.249 billion via a GDR.

However, DRAM prices did not bounce back and the company found itself unable to generate enough cash to meet a new set of debt maturities. This liquidity crunch forced it into a second debt re-scheduling and a take-over by its banks.

At the height of its problems, Hynix had amassed gross debt of $10 billion, equating to a debt to EBITDA ratio of 12 times. By the first quarter of 2005, debt had been shaved to $1.8 billion and debt to EBITDA to 0.6 times.

Hynix now has a credit profile and market cap similar to arch rival Micron. The US DRAM giant currently reports a debt to EBITDA level of 0.7 times and gross debt of $1.2 billion.

Analysts say Hynix has been able to re-configure its balance sheet for a number of reasons. It has sold assets, pared capex and benefited from an upturn in the industry.

Indeed, one of investors' main concerns during roadshows was whether an unfettered Hynix will start to throw money at capex to the detriment of its credit ratios.

Analysts believe this is unlikely given the way it has conducted its business over the past two years. During this time, Hynix has leapfrogged Micron and Infineon to become the world's second largest DRAM manufacturer behind Samsung Electronics.

It is also now the world's third largest NAND flash manufacturer behind Samsung and Toshiba, having only entered the market for the first time in 2004.

But this expansion of market share has not come at the expense of its margins. In 2004, the company reported an EBITDA margin of 47%, higher than Micron's 36%.

Analysts have further applauded its move into higher margin DRAM products. These accounted for 40% of its revenues in the first quarter of 2005 compared to 30% the same time last year.

DRAM chips are used in PC's to temporarily store data for fast access, while NAND chips are used in memory cards of communication devices such as MP3 players and digital cameras. The main difference between the two is that DRAM chips do not need to retain data once the device is switched off, while NAND chips do.

Diversifying into NAND should help to stabilise the company's earnings during future industry cycles. The high capex costs, which plague the industry, should have also been mitigated by the adoption of a partial fab-lite strategy.

For example, Hynix has established a joint venture with Taiwan's ProMOS to outsource chip production to the latter's new 12" fab. It has similarly well positioned itself in China where it has majority control of a joint venture with STMicroelectronics to establish a second 12" fab.

By the end of 2006, analysts say Hynix will have more 12" capacity than any of its rivals. Mass production at its own domestic 12" fab began in January.

On a more fundamental basis, analysts believe the sector has begun to enter a cyclical upswing with DRAM prices bottoming in May.

Investors are protected from any temptation to increase capex by the covenants attached to the high yield bond. Like Magnachip, Hynix has committed to a fairly standard consolidated fixed charge coverage ratio of two times.

There is also a change of control put at 101%. But this is only triggered if there is a change of ownership and a ratings downgrade. The downgrade trigger was inserted, as there is likely to be a change of ownership before the bonds mature.

During roadshows, the company said it will continue to pay down debt as it falls due and hopes to reduce net debt below $1 billion over the mid-term. It also said it intends to maintain capex within EBITDA and in the event of a downturn, will use its low cash cost position and capex efficiency to buffer its spending.

Some now believe debt investors stand to make a lot of money from the high yield bond. Others add that too many accounts stayed away because they let the company's past cloud their judgment.

Hynix has had to pay a high price for its history at a time when it hoped investors would applaud the remarkable job it has done transforming its balance sheet over the past couple of years.

As one observer puts it, "Frankly it was a major achievement getting a deal like this done. Markets are still not good and investors were initially very dismissive. When asked if they'd like a one-on-one meeting with management, a lot of portfolio managers said, 'sure, but I think I should tell you I've no intention of buying it'".

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